Don’t Forget About K-2 and K-3

You may remember the pre-tax season stress at the end of 2022 when the IRS updated schedules K-2 and K-3. These little-known schedules made a big splash with their long instructions and added strain to small business owners.

Updates to filing instructions now include a domestic filing exception, which means essentially that domestic passthrough entities may not need to file the forms assuming they meet the criteria for an exception.

The struggle still remains for small businesses that don’t meet exception requirements. Partnerships and S Corportions, regardless of size, must file K-2 and K-3 if there is any foreign ties to the owners or to the organization itself. Originally, these instructions meant that an owner of a passthrough entity who even so much as had foreign dividends on a personal 1099 would tip off the requirement for K-2 and K-3 to the filed. The stringent rules put a heavy burden on tax preparers and created a compliance nightmare for determining applicability, especially in entities with more “silent” partners and shareholders.

The domestic filing exception now includes the language that says the entity and its owners had “no foreign activity, or little foreign activity”. This seems to imply that owners who are potentially receiving foreign dividends in small amounts perhaps as part of a personal stock portfolio might now reasonably be exempt.

Domestic filing exceptions still only apply to organizations with only U.S. partners and shareholders and the partners and shareholders must all be notified that K-2/K-3 will not be provided unless specifically requested.

From a preparers best practices standpoint, it is recommended that you still ensure a representative from the entity complete a foreign disclosures questionnaire, or even that all the individual owners do. Like any foreign disclosures requirement, skipping these forms when they are required can result in large penalties even to the individual partners and shareholders. It’s unclear what “limited” foreign activity constitutes, but documenting a questionnaire as part of tax preparation due diligence helps to provide support for preparers.

Don’t forget to include these forms where needed when a foreign disclosure is required.

Christine Gervais

Christine Gervais is a licensed CPA, using her skills to help businesses grow and achieve their fullest potential. Christine has a Master’s degree in accounting from Southern New Hampshire University in addition to holding her CPA license for over a decade. Notably, Christine is a nationally recognized speaker providing education to other CPAs on how to best serve clients as well as instruction on a wide variety of topics for business owners on how to maximize success. Christine prides herself on the value she can bring to clients with her extensive tax knowledge and provides strategic, forward-thinking financial strategies to help clients grow. When not behind her desk, you can find Christine spending quality time with her daughter and stepson or tending to the family’s excessively loved farm animals.

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